The Impact of AIIB on the World Bank

Zichen Wang

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In late January, International Organization (IO), a leading peer-reviewed journal that covers the entire field of international affairs, published The Impact of China's AIIB on the World Bank where three authors estimate an average reduction of 22 percent in the annual number of new World Bank infrastructure projects in developing Founding Members of the Asian Infrastructure Investment Bank.

The World Bank, under the stewardship of the United States, stands out as the global leader among international development organizations. Does China's establishment of the Asian Infrastructure Investment Bank (AIIB) undermine this status? Examining this question, we focus on the borrowing practices of a special set of countries: the founding members of the AIIB. These founders openly defied the public preference of the United States, arguably to create a potential rival to the World Bank. Using a new causal inference method, Pang, Liu, and Xu's Dynamic Multilevel Latent Factor Model—as well as several well-known estimation models as robustness checks—we document at least a temporary decrease in the number of World Bank infrastructure projects that the developing AIIB founders have entered into. This study presents the first systematic evidence that China's AIIB could unsettle the political influence the United States has enjoyed over developing countries through its leadership of the World Bank. An important set of countries may be parting ways with the World Bank and looking to a Chinese institution for leadership in the world of development.

The authors are Jing Qian, PhD Candidate, Department of Politics, Princeton University; James Vreeland, Professor of Politics and International Affairs, Department of Politics and School of Public and International Affairs, Princeton University; and Jianzhi Zhao, Associate Professor, School of International Relations and Public Affairs, Fudan University, Shanghai, China.

Founded alongside the rise of the United States at the close of World War II, the World Bank has remained throughout its history the leading international development organization. Over the years, however, it has been criticized for several problems, including unsustainable development policies, long project approval times, and inadequate financing capacity for infrastructure projects. It has also been associated with intrusive policy conditionality.

In 2016, rising China established the Asian Infrastructure Investment Bank (AIIB), with fifty-seven founding members. This new institution joins two dozen multilateral development banks (MDBs) that have been formed since 1944. 5 Its ostensible goal is to fill a shortfall in infrastructure investment in Asia and beyond. Yet the AIIB stands out for several reasons: its size and ambition; the absence of the United States and Japan; and, perhaps most importantly, Chinese leadership of the institution. The AIIB might represent real competition for the World Bank and for Western political influence in the developing world.

Of course, the prospect of alternative funding does not necessarily force governments to shift away from the West’s foremost development organization. The AIIB has largely aligned its lending standards with those of other MDBs, and it might simply fit well within the existing MDB complex with little disruption to the World Bank.

Scholars have found that Western donors have scaled back their demands of recipient countries in response to competition. Still,governments dissatisfied with the World Bank maybe looking for new options. To assess this possibility, we consider a specific group of developing countries that joined the AIIB: the founding members. In considering the founders, we emphasize the importance of key countries undertaking costly action to signal their interest in new leadership of theglobal economy. In studying the founding members of the AIIB,we consider a costlier signal.The action constituted no mere summit meeting,but rather the founding of an institution—perhaps a sign that they are looking for alternatives to the World Bank.

For these developing countries that helped found the AIIB, we hypothesize fewer World Bank projects in the area of infrastructure—the specialty of the AIIB. In testing our hypothesis, we pursue an innovative identification strategy, using a recently developed method, the Dynamic Multilevel Latent Factor Model (DMLFM). This model serves as an alternative to the difference-in-differences approach when the parallel-trends assumption is violated. Unlike the synthetic control method for comparative case studies, this approach accommodates multiple treated units and also corrects for biases induced by unit-specific time trends. We further analyze the data using difference-in-differences, negative binomial, Poisson, and two-way fixed effects models, as well as the generalized synthetic control (Gsynth) method.

Analyzing data on World Bank projects for 155 recipient countries from 1992 to 2019, we find at least short-run evidence supporting our hypothesis: a drop in participation in World Bank infrastructure programs by the developing founding members of the AIIB. Specifically, we estimate an average reduction of 22 percent in the annual number of new World Bank infrastructure projects in these countries. The estimated effect is attenuated in 2019, suggesting that it may be temporary.

Still, our methodology shows at least a temporary effect through 2019 for the developing AIIB founders. The DM-LFM accounts for both time- and unit-specific treatment and covariate effects, and addresses potential bias due to unobserved time-varying confounders by estimating latent factors. The DM-LFM relies on the key assumption of latent ignorability, which assumes that treatment assignment is ignorable conditional on observed covariates and unobserved latent variables. Estimates could be biased through a feedback effect, however, if the decision to become AIIB founders and the 2016 establishment of the AIIB were determined by countries’ previous borrowing from the World Bank. To address this possible selection bias, we conduct placebo diagnostics. The estimated negative effect emerges only with the founding of the AIIB in 2016, not before, which furthers confidence in our results.

Our approach does not enable us to distinguish whether the effect is driven by demand (the decisions of the AIIB founders) or supply (the decisions of the World Bank). Our limited interview evidence suggests that the mechanism runs through the demand channel, which is consistent with the bold move of the founders to establish the AIIB. As for a supply channel, we analyze key dependent variables from the literature—such as US voting behavior on the World Bank executive board, and levels of World Bank conditionality. We find no convincing evidence that the World Bank is punishing the founders. Furthermore, we find an effect of AIIB founding membership only on infrastructure projects, not on non-infrastructure projects—where AIIB founders still rely on World Bank projects because the AIIB has not yet focused on them.

We conclude that the effect we estimate is driven by demand. When it comes to infrastructure, the AIIB founders have begun to turn their backs on the World Bank. We recognize that this finding could be a result of “crowding out,” if AIIB projects simply replace World Bank projects. But not all the developing AIIB founders actually participated in AIIB projects during our sample period, and, interestingly, our results are not driven by AIIB project participation—the effect holds for both sets of founders. While we expect all the developing founders to draw on AIIB funding eventually, these countries appear to have become emboldened by the founding of the AIIB to distance themselves from the US-led World Bank—some of them even before entering into AIIB projects.

The AIIB founders may have turned away from these World Bank projects as a costly signal to encourage World Bank reforms. On the other hand, they might genuinely prefer China’s institution and be willing to forgo the benefits of working with the World Bank to avoid the costs (slow approval and intrusive policy advice) as they look forward to working with the AIIB.

To sume up, this research presents the first systematic evidence that the World Bank is losing ground to China’s AIIB. The AIIB may thus represent a challenge to the political influence the United States has enjoyed over developing countries through its leadership at the World Bank. While we do not yet know how long the effect will last, the effect we estimate for 2016–2019 is stark, representing a drop of participation in World Bank infrastructure projects of about 22 percent for the AIIB founders. And we suspect that our findings represent only the tip of the iceberg. We expect many studies to follow showing how international institutions led by China are competing with those of the United States.

Considering previous findings, our results are surprising. That the World Bank is losing to a Chinese-led institution seems to disagree with other recent studies. Recall that Humphrey and Michaelowa find that Chinese foreign aid has not had a big effect on World Bank lending in Africa, and Zeitz finds that the World Bank has reacted to Chinese aid by providing a greater share of infrastructure projects.

However, there are important differences between these studies and ours. First, these studies consider the World Bank’s competition with China itself, looking at China’s bilateral aid. We focus on the competition between the World Bank and a multilateral institution led by China.

Second, previous studies look for an effect on World Bank lending across all countries, not just the AIIB founders. When it comes to the full set of developing countries, we may not (yet—or ever) detect a negative impact on World Bank lending. The institution is adapting to a new world where it must compete with new alternatives. It is even possible that the World Bank will win back the AIIB founders before they completely turn away. Perhaps the very point of the AIIB founders’ forgoing World Bank projects is to signal credibly their demand for reform. By playing off both institutions, they can achieve better lending terms.

But it is also possible that, for the set of AIIB founders, the ship has already sailed. As competition between the rivals intensifies, it will be important to examine whether the United States and World Bank can win back any founders—and which additional countries begin to lean more heavily in favor of Chinese leadership. Cutting-edge research on AIIB loans shows that the institution is targeting countries economically distant from China, granting them privileged access. So China may use the institution to expand its global influence.

Methodologically, this study also advances the literature on China’s rising role in development. We are the first to apply the DM-LFM approach, and we combine it with other well-known methods to better identify causal effects using observational data. While we call for further research into the theoretical mechanisms, we can conclude with a high degree of confidence that we have identified an effect of AIIB founding membership negatively impacting World Bank infrastructure projects, at least in the short run. We see this result in dialogue with the findings of previous studies. Together, the literature is beginning to provide a picture of how the rising presence of China within the development scene will reshape global politics.